Monthly Dividend Stock In Focus: San Juan Basin Royalty Trust - Sure Dividend

Sure Dividend

High-Quality Dividend Stocks, Long-Term Plan
The Sure Dividend Investing MethodMember's Area

Monthly Dividend Stock In Focus: San Juan Basin Royalty Trust


Updated on April 19th, 2022 by Aristofanis Papadatos

San Juan Basin Royalty Trust (SJT) has a high dividend yield of more than 10%, based on its annualized distributions over the first three months of 2022. It is one of more than 200 stocks with a 5%+ dividend yield. You can see the full list of established 5%+ yielding stocks by clicking here.

San Juan Basin has a very enticing payout, considering the S&P 500 Index has a ~1.3% dividend yield right now. That means San Juan Basin offers about eight times as much dividend income as the average stock in the S&P 500.

San Juan Basin also pays its dividend each month, rather than each quarter like most other stocks. This gives investors the benefit of more frequent dividend payouts.

San Juan Basin is one of only 50 monthly dividend stocks we currently track. You can download our full list of monthly dividend stocks (along with important financial metrics like dividend yields and payout ratios) by clicking on the link below:

 

However, San Juan Basin’s dividend may not be as attractive as it seems. The payout has been slashed repeatedly in recent years, and royalty trusts are a highly risky type of security.

This article will discuss why investors should view royalty trusts like San Juan Basin with a fair dose of skepticism.

Business Overview

San Juan Basin is a royalty trust, established in November 1980. The trust is entitled to a 75% royalty interest in various oil and gas properties across over 150,000 gross acres, in the San Juan Basin of northwestern New Mexico.

On July 31st, 2017, Hilcorp San Juan LP completed its purchase of San Juan Basin assets from Burlington Resources Oil & Gas Company LP, a subsidiary of ConocoPhillips (COP).

More than 90% of the trust’s production is comprised of gas, with the remainder consisting of oil. The trust does not have a specified termination date. It will terminate if royalty income falls below $1,000,000 per year over any consecutive two-year period.

The past four years have been difficult for San Juan Basin. Not surprisingly, this was due to lower oil and gas prices. Things became even more challenging in 2020, as the coronavirus pandemic resulted in a steep decline in the prices of oil and gas.

The average realized price of natural gas for San Juan Basin decreased from $1.79 in 2019 to $1.51 in 2020. The average realized price of oil decreased from $45.11 per barrel in 2019 to $31.47 per barrel in 2020. As a result, its distributable income per unit dipped 9%, from $0.174 in 2019 to $0.159 in 2020. Due to its poor cash flows, the trust suspended its distribution for 6 months in 2019 and another 4 months in 2020.

Fortunately, San Juan Basin recovered strongly in 2021 thanks to the recovery of the energy market from the pandemic. Thanks to the impressive rally of the price of natural gas, which resulted from pent-up demand after the pandemic and tight supply, distributable income per unit nearly quintupled, from $0.159 in 2020 to $0.77 in 2021.

Even better, the price of natural gas has rallied to a 13-year high this year due to the sanctions of European countries on Russia. Europe generates 31% of its electricity from natural gas provided by Russia but it is now doing its best to reduce its reliance on Russia. As a result, there has been a huge increase in LNG exports from the U.S. to Europe. Consequently, the U.S. natural gas market has become extremely tight and hence the price of U.S. natural gas has rallied to a 13-year high lately.

This is an ideal development for San Juan Basin. Based on its distributions of $0.31 per unit in the first three months of 2022, the trust is likely to offer total distributions of at least $1.24 per unit this year. Such a performance will mark a 7-year high for the trust.

Growth Prospects

There are two significant growth catalysts for San Juan Basin moving forward. The first is higher commodity prices, which would help San Juan Basin generate higher cash flows. Specifically, higher gas prices would be a huge boost for San Juan Basin, since gas accounts for the vast majority of production.

The other major growth catalyst for San Juan Basin would be if the trust’s oil and gas properties produced for longer than is currently expected. San Juan Basin is not exactly sure of the lifespan of the trust. It has hired independent petroleum engineers, who conservatively estimated that the trust is likely to continue to produce for at least another 10-15 years.

These two factors will determine whether San Juan Basin is a good investment. The trust is not permitted to engage in any business activity, which includes using any portion of the trust estate to acquire additional properties.

San Juan Basin ended 2021 with proved reserves of 234 thousand barrels of oil, and 84.1 million cubic feet of natural gas.

If the trust lasts 10-15 years, at the 2020 distribution rate of $0.159 per unit, investors would receive approximately $1.59-$2.39 per unit in distributions. Again, it is worth noting that San Juan Basin did not pay any distributions for 10 months in 2019-2020.

The suspension of distributions for several months is a stern reminder that distributions are not a guarantee from the trust. Royalty trusts like San Juan Basin are essentially bets on commodity prices, which will be the major determining factor as to whether the distribution is sustainable.

As mentioned above, San Juan Basin is likely to post a 7-year high distributable income per unit of approximately $1.24 this year thanks to the rally of the price of natural gas to a 13-year high. As the sanctions of Europe on Russia are not likely to be withdrawn anytime soon, the U.S. are likely to keep exporting hefty amounts of LNG to Europe and thus gas prices are likely to remain elevated in the remainder of this year.

On the other hand, natural gas is well-known for its high cyclicality. We thus expect gas prices to enter another downcycle at some point in the future, just like they always have. When that happens, San Juan Basin will have to reduce its distributions.

Dividend Analysis

As a trust, San Juan Basin’s distributions are classified as royalty income. Distributions are considered ordinary income, and are taxed at the individual’s marginal tax rate. Since gas prices are so important to royalty trusts’ cash flow, it is no surprise that San Juan Basin’s dividends have declined when gas prices have declined, such as from 2014 to 2016 and again in 2020.

San Juan Basin made the following distributions since the previous oil and gas industry downturn:

Despite an uptick in distributions in 2017, declining commodity prices have caused San Juan Basin’s fundamentals to steadily deteriorate since 2014. This, in turn, led to lower distribution payments.

On the bright side, San Juan Basin recovered strongly from the pandemic last year. Moreover, in the first three months of this year, it has offered distributions per unit of $0.31. At this rate, San Juan Basin would pay out approximately $1.24 per unit for the full year. This payout level would represent a yield of 10.9% based on the current unit price of $11.40.

If oil and gas prices can maintain current levels or increase further, San Juan Basin’s distributions could increase to a level that makes the stock attractive. For example, if the trust lasts another 10 years, investors will want a dividend yield well in excess of 10% annually, to make San Juan Basin a successful investment.

Of course, there is no guarantee of a longer life span, nor is there a guarantee that oil and gas prices will remain around their multi-year highs. As a result, royalty trusts are a particularly risky way to invest in the energy sector.

Final Thoughts

Investing in San Juan Basin right now is essentially making a bet on two things—high oil and gas prices, and a longer-than-expected lifespan of the trust.

Royalty trusts can be a good source of dividend income thanks to their high yields. But investors need to make sure the trust’s assets will not run out before the initial investment is paid back. It appears that San Juan Basin investors will need the extremely high prices of natural gas and oil to remain in place for years in order to make the stock a good investment.

We view this favorable scenario as highly unlikely. As such, investors looking for less risk from a dividend stock are encouraged to avoid royalty trusts like San Juan Basin.

If you are interested in finding more high-quality dividend growth stocks suitable for long-term investment, the following Sure Dividend databases will be useful:

The major domestic stock market indices are another solid resource for finding investment ideas. Sure Dividend compiles the following stock market databases and updates them monthly:

Thanks for reading this article. Please send any feedback, corrections, or questions to support@suredividend.com.


More from sure dividend
The Sure Dividend Investing MethodMember's Area